How Some Small Business Owners Get Back More Taxes Than They Paid

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  • You can get a tax refund by maximizing your deductions and credits.
  • Refundable credits can result in a negative tax liability.
  • Some of the most common tax credits are at least partially refundable.

Get a refund even if you didn't owe any taxes.

Usually, when you get a tax refund it's because you paid more taxes than you owed for the year. Most people don't profit at tax time. It is, however, entirely possible to get a tax refund that exceeds the amount you paid in. This can happen if you qualify for at least one refundable tax credit.

Tax deductions, tax credits, and refundable tax credits

The way to legally minimize your tax bill is to claim all of the tax deductions and tax credits to which you are entitled.

Take a look at these examples, using an individual taxpayer who earned $50,000 as an example.

How do tax deductions work?

A tax deduction lowers your taxable income. A deduction saves you a small percentage of the amount of the deduction. Instead of owing taxes on the higher amount, you owe taxes on the lower amount.

If you are in the 20% tax bracket and you have a $1,000 deduction, you will save $200 (20% of $1,000).

How do tax credits work?

Tax credits lower your tax bill. If you qualify for a $1,000 tax credit, you will save $1,000 in taxes.

How do refundable tax credits work?

Refundable credits can be refunded to you, even if you don't owe taxes. If you owe $0 in taxes and you qualify for a $1,000 refundable tax credit, you will get a check for $1,000 from the IRS.

How do you get to zero tax liability and qualify for a refund?

Let's look at a simplified example. We will assume you are self-employed and you itemize deductions. The sum of your deductions is greater than the standard deduction ($12,950 in 2022).

Tax liability on $50,000 with no deductions or credits:

Taxable income 2022 tax rate Tax you owe
$50,000 $4,807.50 plus 22% of the excess over $41,775 $6,617.00
Data source: Author's calculations.

Now we deduct marketing expenses, business-related auto expenses, depreciation, business rent, the cost of subcontractors, business interest payments, job supplies, legal fees, business travel, and any other legitimate expense that you can document.

Tax liability after $30,000 in deductions but before credits:

Taxable income 2022 tax rate Tax you owe
$20,000 $1,027.50 plus 12% of the excess over $10,275 $2,194.50
Data source: Author's calculations.

You were enrolled half time (just two classes) in a credential program and qualified for the American Opportunity Tax Credit (AOTC). You spent $1,500 on qualified education expenses. You get a $1,500 credit because the amount of the credit is 100% of the first $2,000 in qualified expenses.

You contributed $500 to your IRA, so you qualify for the Saver's Credit. That's a tax credit that rewards you for saving money in a qualified retirement account. In this case, the credit is 50% of your contribution, or $250.

You qualify for the Earned Income Tax Credit (EITC). For a single taxpayer with no children in 2022, the credit is $560.

Tax liability after deductions and credits:

Taxable income 2022 tax rate Tax you owe
$20,000 $1,027.50 plus 12% of the excess over $10,275 ($115.50) (negative tax bill)
Data source: Author's calculations.

Your tax bill is now below zero, at -$115.50. Note that this isn't the amount of your refund, though. The Saver's Credit is not refundable, the AOTC is only partially refundable, and the EITC is fully refundable. You'd want to use tax software or consult a tax preparer to figure out the exact amount owed to you by the IRS.

Can W-2 employees qualify for refundable tax credits?

Payroll employees can absolutely take advantage of tax credits. This scenario might be more likely to work for a self-employed person, though, because many business-related tax deductions are not available to those who work as employees for a company, making it harder to get their taxable income down. For instance, although most self-employed people can deduct their health insurance premiums, employees can't unless the total of all of their healthcare expenses for the year exceeds 7.5% of their income.

How many tax credits are there?

Tax law changes now and then, but besides the tax credits mentioned above, you might be eligible for a few other common credits. They include the Child Care Tax Credit, the Lifetime Learning Credit, the Adoption Credit, and others. Get more information from a tax professional. If you don't use one, pay special attention to the questions asked while you use tax preparation software.

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